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ISSN : 1598-7248 (Print)
ISSN : 2234-6473 (Online)
Industrial Engineering & Management Systems Vol.19 No.3 pp.561-575
DOI : https://doi.org/10.7232/iems.2020.19.3.561

Co-determination of Capital Structure and Profitability: An Empirical Test of Indonesia Stock Exchange

Teddy Chandra*, Stefani Chandra, Evelyn Wijaya, Jenifer Chandra, Martha Ng
Pelita Indonesia Institute of Business and Technology, Jl. Jend. Ahmad Yani No 78-88 Pekanbaru 28127, Indonesia
*Corresponding Author, E-mail: teddy.chandra@lecturer.pelitaindonesia.ac.id
May 6, 2020 June 22, 2020 June 30, 2020

ABSTRACT


This research aims to analyze the determinant of capital structure and profitability. Besides, it will also be tested to know whether there is a reciprocal relationship between this capital structure and profitability or not. The object of this research is using the registered manufacture company on the Indonesian Stock Exchange. The number of companies pointed as the samples in this research is 115 companies. The observation period is between 2012 – 2018 or for about 7 years so that the analysis units of this research are 805. The analysis tool used in this research is the Structural Equation Modeling by using generalized structural component analysis. It creates the results of Nondebt tax shield, effective tax rate, financial flexibility, liquidity; growth, uniqueness, assets utilization, firm size, tangibility, volatility, and profitability have an impact on the capital structure. It is known that only a firm age that doesn’t have any significant impacts on the capital structure. Liquidity, growth, firm age, uniqueness, firm size, tangibility, volatility, advertising, assets turnover, and capital affect profitability. Besides that, capital structure and profitability have a significant reciprocal relationship.



초록


    1. INTRODUCTION

    Research on capital structure and profitability is an interesting topic for researchers in the field of financial management. In recent years, more and more studies have examined the determinant of capital structure and determinant of profitability. Very few researchers do a combination of the effect of capital structure on profitability or the effect of profitability on capital structure. Ahmed Sheikh and Wang (2011) found a significant negative effect on the profitability of capital structure. The high cost of capital and obstacles in obtaining funds encourage companies in Pakistan to use internal funds rather than debt. Alipour et al. (2015) who examined manufacturing companies listed on the Tehran Iran Stock Exchange also found a significant negative effect on the profitability of capital structure. Yang et al. (2010) researching nonfinancial companies in Taiwan and using structural equation modelling (SEM) also found a significant negative effect on the profitability of capital structure. The results of research that found a negative effect of profitability on other capital structures are (Acaravci, 2015;Chang et al., 2014;Chen, Jiang, and Lin, 2014;Shah and Kausar, 2012;Chen and Chen, 2011). On the contrary (Tse and Rodgers, 2014) who examined manufacturing companies listed on the Shanghai Stock Exchange found a significant positive effect on the profitability of capital structure. These results are in line with findings made (Al Ani and Al Amri, 2015;Pacheco and Tavares, 2017;Vo, 2017;Yinusa et al., 2015).

    Meanwhile, research on the effect of capital structure on profitability has also been widely carried out. Dawar (2014) who examined companies from different sectors on the Bombay Stock Exchange from 2003-2012 found a significant negative effect on the capital structure on profitability. That is, an increase in debt will result in a decrease in profitability. The results of this study are also supported by other studies conducted by (Işık, 2017;Odusanya et al., 2018;Twairesh, 2014;Vătavu, 2015;Yazdanfar and Öhman, 2015). In contrast (Gill et al.,, 2011) who examined American service and manufacturing companies listed on the New York Stock Exchange found a significant positive effect on the capital structure on profitability for both the service and manufacturing sectors. Abor (2005) found a significant positive effect on capital structure, especially long term debt, on profitability in Ghana and South Africa. Whereas Short term debt and total debt tend to have a significant negative effect on profitability.

    Although previous studies have tested the relationship between capital structure and profitability, very few have examined the simultaneous interaction of these two variables. Most researchers conduct one-way effects such as the effect of capital structure on profitability or the effect of profitability on capital structure. Norvaisiene (2012) tried to do an interaction study between capital structure and profitability. But in his analysis, the effect of capital structure on profitability and the effect of profitability on capital structure is still tested, using linear regression. In this research, we try to examine the mutual influence between capital structure and profitability and examine the factors that influence these two endogenous variables. This research was motivated by other research conducted by Yang et al., (2010) who used the structural equation models (SEM). In this study, we also use SEM with capital structure and profitability as endogenous variables. Only research conducted (Chandra et al., 2019) found a reciprocal relationship between capital structure and profitability. In this research, capital structure has a significant negative effect on profitability, while profitability has a positive effect on capital structure.

    The aims of this study are as follows; first, find the factors that influence capital structure. Secondly, find factors that influence profitability. Third, examine the mutual effect between capital structure and profitability. Is there an effect of capital structure on profitability and vice versa? Do these two variables influence each other? Or is there one that is more dominant than the others? In this study, a sample of manufacturing companies listed on the Indonesia Stock Exchange is used.

    2. LITERATURE REVIEW

    Since the publication of the paper (Hekmatpour et al., 2017) with “irrelevance theory” which uses the assumption of a perfect market, free taxes, no transaction costs and so on, capital structure is said to be an irrelevance in determining firm value. But on the criticism of various parties, Modigliani and Miller were forced to revise their theories. In 1963 they relaxed their assumptions with taxes. The results of this revision show that capital structure has a positive effect on profitability. This means that the greater the debt used, the more profitable it will be. Since this revision, researches have emerged, the pros and cons of capital structure and its relation to profitability. Trade-off theory and pecking order theory are two theories that are very widely adopted to be able to answer this relationship.

    The trade-off theory proposed by Mehr (2019) argues that the use of debt is a good thing for a company because an increase in debt will reduce the cost of debt as a result of the tax shield that will ultimately increase profits. But the use of debt that is too large will increase the risk so that it will increase the cost of financial distress. So this theory suggests that companies can use debt, but should be limited to the marginal present value of the tax shield equal to the marginal present value of the cost of financial distress (Chen et al., 2014).

    Pecking order theory which is stated by (Chen et al., 2014) states companies tend to use internal financing first. If funding needs cannot be met by internal financing, the next choice is debt. Equity is a last resort. This is because managers avoid information asymmetry. Investors tend to believe that if a company issues shares, stock prices will fall after the stock issue is announced.

    The determinant of Capital Structure and Profitability

    Before the structural model analysis made for this study, it will be discussed about the determinant of capital structure and determinant of profitability here.

    2.1 The determinant of Capital Structure

    2.1.1 Profitability (Y2)

    Based on pecking order theory, companies that have large profitability tend to use internal financing and reduce the use of debt. Conversely, companies that have small profitability will tend to use debt as a source of funds. This is done to avoid the use of equity which tends to cause information asymmetry problems. As a result, profitability will negatively affect capital structure. Research conducted by (Alipour et al., 2015) which examined manufacturing companies listed on the Tehran Stock Exchange Iran, found a negative effect of profitability on capital structure. In his research, he found that the Iranian companies which have high profitability tend to use internal financing and reduce the use of debt. This result is consistent with research conducted by (Acaravci, 2015;Ahmed Sheikh and Wang, 2011;Chandra, 2015;Chang et al., 2014;Vo, 2017;Yang et al., 2010).

    On the contrary, according to the trade-off theory, companies that have high profitability tend to use higher debt. This means that profitability will have a positive effect on capital structure. Research conducted by (Pacheco and Tavares, 2017) on small and medium enterprises (SMEs) in Portugal found that profitability represented by return on equity (ROE) had a positive effect on both short term debt, long term debt and total debt. This is in line with research conducted by (Yinusa et al., 2015) who examined companies in Nigeria, also found ROE has a positive effect on long term debt. Tse and Rodgers (2014) in his research on companies in Shanghai found a significant positive effect of profitability on long term debt in the wholesale/retail sector. While for other sectors it is not significant. Research conducted by Al Ani and Al Amri (2015) on companies registered with Omani Industrial Companies, found a positive effect of profitability on leverage in the chemical sector. Whereas all sectors (chemical, food & construction) have a significant negative effect. While in the food & construction sector, profitability does not have a significant effect on leverage.

    Indicators of profitability consist of “Prof1 = earnings before interest and tax” divided by total assets (EBIT / TA) (Chadha and Sharma, 2015b), Prof2 = cash flow from operating activities divided by total assets (CFO / TA) (Yang et al., 2010), and Prof3 = operating income divided by total sales (OI / TS) (Yang et al., 2010). By looking at the condition of Indonesia’s economy which tends to be stable, the hypothesis made here will adjust to the trade-off theory.

    • H1: Profitability has a positive influence on the capital structure.

    2.1.2 Non-Debt Tax Shields (X1)

    According to the pecking order theory, companies are more likely to use internal financing compared to external financing. Nondebt tax shields are part of the burden of depreciation and amortization from companies that can be used as a source of corporate financing. So it can be said that non-debt tax shields have a negative effect on capital structure. Research conducted by Evertsson (2012) found nondebt tax shields have a negative effect on total debt. The results of this study are in line with research conducted by (Acaravci, 2015;Ahmed Sheikh and Wang, 2011;Pacheco and Tavares, 2017). On the contrary Chadha and Sharma (2015b) who examined manufacturing companies in India found a positive effect of non-debt tax shield on capital structure. This means that the greater the depreciation value owned by companies in India tends to be used as attractive collateral so that it will encourage companies to increase their debt. The results of this study are in line with research conducted.

    Nondebt tax shield indicator used in this study is NDTS = depreciation divided by total assets (Dep / TA) (Chadha and Sharma, 2015b). In this study the hypotheses used are as follows:

    • H2: Non-debt tax shields have a positive influence on capital structure.

    2.1.3 Effective Tax Rate (X2)

    Alipour et al. (2015) suggested that companies maximize the use of debt because of the benefits of tax deduction of interest payments. According to the trade-off theory, an increase in the effective tax rate can increase a company's capital structure. So it can be said that the effective tax rate has a positive effect on capital structure. On the contrary, research conducted by (Al Ani and Al Amri (2015) which examined companies in Turkey, found a negative effect of the effective tax rate on capital structure. While research conducted by (Alipour et al., 2015) did not find any significant effect of the effective tax rate on capital structure.

    The effective tax rate indicator used in this study is EffTax = tax divided by earnings before taxes (T / EBT). In this study, a hypothesis can be made as follows:

    • H3: Effective tax rate has a positive influence on capital structure.

    2.1.4 Financial Flexibility (X3)

    According to the pecking order theory, companies with high profitability tend to reduce external financing. Companies that have high profitability will have greater financial flexibility. It can be said that companies that have high financial flexibility tend to reduce the use of external financing. So financial financing has a negative influence on capital structure. These results are consistent with research conducted by (Alipour et al., 2015) who found a significant negative effect on financial flexibility on capital structure. While research conducted on companies in Egypt by (Nimsai and Siriyod, 2019), found a significant negative effect of financial flexibility on short term debt. As for the long term debt, this does not have a significant effect.

    In this study, the financial flexibility indicator used is FinFlex = retained earnings divided by total assets (RE / TA). The hypotheses that can be used in this study are:

    • H4: Financial flexibility has a negative influence on capital structure.

    2.1.5 Liquidity (X4)

    According to the pecking order theory, companies that have high liquidity tend to reduce the use of external financing. So that liquidity has a negative effect on capital structure. This opinion is also supported by Haron (2016), which states the agency cost of high liquidity will make creditors limit the number of loans to companies. The results of the study (Haron, 2016) which examined nonfinancial companies in Indonesia, found a significant negative effect of liquidity on capital structure.

    In contrast, according to the trade-off theory, companies must ensure sufficient liquidity to obtain debt in meeting company commitments. This means that companies that have high liquidity tend to use debt. So there is a positive effect of liquidity on capital structure. Shah and Kausar (2012) in his research on companies in Pakistan found a positive effect on long term debt. And negative significant to the short term debt and total debt. Alipour et al. (2015) found a significant positive effect on liquidity on short term debt. But liquidity has a negative effect on long term debt. Likewise, research conducted by (Pacheco and Tavares, 2017) also found a positive effect of liquidity on long term debt, while for short term debt and total debt there was a negative effect.

    In this study liquidity indicators are Liq1 = current assets divided by current debt (CR / CD) (Alipour et al., 2015;Chadha and Sharma, 2015b), Liq2 = cash divided by current debt (C / CD) (Dawar, 2014) and Liq3 = working capital divided by total assets (WC / TA) (Alipour et al., 2015). The hypothesis used in this study is:

    • H5: Liquidity has a negative influence on capital structure.

    2.1.6 Growth (X5)

    Pecking order theory argues, companies that have high growth tend to take advantage of internal financing first. If it is not enough, then use the debt. As a result, companies that have high growth tend to owe to avoid the impact of information asymmetry (Alipour et al., 2015). Companies that have high growth need a lot of loans and they can borrow more. Agency theory suggests that debt for companies is a solution to avoid problems that arise between managers and investors. Therefore growth has a positive influence on capital structure. The results of the study (Chang et al., 2014) on companies in China found a positive effect of growth on capital structure. These findings are in line with findings made by (Acaravci, 2015;Shah and Kausar, 2012;Vo, 2017). Based on the trade-off theory, growth has a negative influence on capital structure (Chen et al., 2014). Alipour et al. (2015) found a negative effect of growth on capital structure. This finding is in line with research conducted (Chandra, 2015;Chen and Chen, 2011;Yinusa et al., 2015).

    In this study the growth indicators used are growth1 = growth in sales (Dawar, 2014), Growth2 = growth in total assets (Chadha and Sharma, 2015b;Yang et al., 2010) and Growth3 = capital expenditure divided by total assets (Ahmed Sheikh and Wang, 2013;Yang et al., 2010). The hypothesis made in this study is:

    • H6: Growth has a positive influence on capital structure.

    2.1.7 Firm Age (X6)

    Dawar (2014) argued firm age has a negative effect on capital structure. This means that new companies tend to use more debt than old companies. This finding is following research conducted by (Pacheco and Tavares, 2017;Yinusa et al., 2015). On the contrary Abor (2005) found firm age has a positive effect on capital structure. Companies that have long tended to have a better reputation, so they will be easier to get debt. Chadha and Sharma (2015b) who examined manufacturing companies in India also found a positive effect on firm age on capital structure. The firm age indicator in this study is firm age is calculated as the number of years since the company was incorporated to each year of the period under study (Chadha and Sharma, 2015b). The hypothesis used in this study is:

    • H7: Firm age has a positive influence on capital structure.

    2.1.8 Uniqueness (X7)

    Titman and Wessels (1988) states that uniqueness has a negative effect on capital structure. This is caused by the uniqueness of specialization of the company's products which will result in high costs. Because uniqueness makes workers and suppliers must have specific skills and capital. This is not very liquid and it is very difficult to turn to other businesses. For this reason, companies will find it difficult to get loans, so the effect of uniqueness on capital structure is negative. The results of this study are in line with research conducted by (Acaravci, 2015). On the contrary (Chang et al., 2014) found that uniqueness does not have a significant effect on capital structure.

    The indicators of uniqueness in this study are Uniq1 = research and development divided by total sales (RD / TS) (Yang et al., 2010) and Uniq2 = selling expenses divided by total sales (SE / TS) (Chadha and Sharma, 2015b;Yang et al., 2010). The hypothesis used in this study is:

    • H8: Uniqueness has a positive influence on capital structure.

    2.1.9 Assets Utilization (X8)

    The use of debt in capital structure will lead to agency costs (Ahmed Sheikh and Wang, 2011). Based on the free cash flow theory, the higher the asset utilization ratio, the more efficient managers will be in utilizing assets (Acaravci, 2015). According to agency theory, asset utilization has a negative effect on capital structure. With the increase in asset utilization, the efficiency of managers in utilizing company assets will be better so as to encourage increased company cash flow and ultimately do not require external financing. On the contrary (Alipour et al., 2015) found a positive effect of asset utilization on capital structure. This means that increasing asset utilization will increase efficiency in utilizing company assets so that there will be an increase in cash flow. According to the free cash flow theory, an increase in cash flow will be demanded by shareholders to be distributed in the form of dividends so that managers are encouraged to increase debt.

    The assets utilization indicator in this study is AsUtil = sales divided by total assets (Alipour et al., 2015). The hypotheses in this study are:

    • H9: Assets utilization has a negative influence on capital structure.

    2.1.10 Firm Size (X9)

    Based on trade-off theory, large companies have a lower risk of bankruptcy, which is marked by a better credit rating than small companies, making them more daring in debt. This means that the effect of firm size on capital structure is positive. Chen et al. (2014) in his research found that large companies in China tend to have more debt, so firm size has a positive effect on capital structure. These results are in line with research (Ahmed Sheikh and Wang, 2011;Chandra, 2014;Chang et al., 2014). On the contrary, according to the pecking order theory, large companies will use internal financing and reduce the use of external financing. This is done to avoid information asymmetry, so the use of debt is lower. This means that there is a negative influence on the firm size on capital structure. These results are in line with research conducted (Acaravci, 2015) on manufacturing companies in Korea, finding a negative effect on the firm size on capital structure. While research conducted by (Pacheco and Tavares, 2017) found firm size has a positive effect on long term debt. As for the short term debt and total debt, it has a negative effect.

    In this study firm size indicators are Size1 = Ln sales (Ahmed Sheikh and Wang, 2011;Yang et al., 2010), Size2 = Ln total assets (Dawar, 2014), and Size3 = Ln market value of equity (Acaravci, 2015). The hypothesis made in this study is:

    • H10: Firm size has a positive influence on capital structure.

    2.1.11 Tangibility (X10)

    According to the trade-off theory, companies with large tangibility will need collateral assets to cover debts when they go bankrupt. As a result, companies need more debt to get more tangibility assets. So it is said tangibility assets will have a positive effect on capital structure. (Yang et al., 2010) in his research on companies in Taiwan, found tangibility assets have a positive effect on capital structure. These results are in line with research conducted by (Chiang et al., 2010). On the contrary, according to the pecking order theory, even though the company's tangibility is very large, the company will still prioritize the use of internal financing. This means that tangibility has a negative effect on capital structure. Research (Acaravci, 2015) found a negative influence of tangibility on capital structure. Other studies that found negative influences were (Acaravci, 2015;Chandra, 2014;Vo, 2017).

    Tangibility indicators in this study are tang1 = total fixed assets plus inventory divided by total assets (Ahmed Sheikh and Wang, 2013) and Tang2 = total fixed assets divided by total assets (Alipour et al., 2015). The hypothesis made for this research is:

    • H11: Tangibility has a positive influence on capital structure.

    2.1.12 Volatility (X11)

    Trade-off theory suggests companies with high risk to avoid debt. This means that volatility has a negative effect on capital structure (Titman and Wessels, 1988). Research conducted by (Alipour et al., 2015) also found that high-risk Iranian companies tended to reduce debt. Likewise, research conducted (Ahmed Sheikh and Wang, 2011) also found a negative effect of volatility on capital structure. Pakistani companies are still dependent on bank loans. The majority of banks are privately owned, they will not lend funds to companies that have high volatility. On the contrary (Chen et al., 2014) found a positive effect of volatility on capital structure. Despite having high volatility, Chinese companies that are dominated by state companies can still get large amounts of loans. These results are in line with research conducted by (Tse and Rodgers, 2014).

    Volatility indicators in this study are Vol2 = the standard deviation of the first differences in the ratio of operating income divided by total assets (σ (Δ (OI / TA))) (Yang et al., 2010), Vol3 = standard deviation of the first differences in the ratio of EBIT divided by total assets (σ (Δ (EBIT / TA))) (Chandra, 2015;Yang et al., 2010) and Vol4 = standard deviation of return on equity (Chen et al., 2014). The hypothesis made in this study is:

    • H12: Volatility has a negative influence on capital structure.

    2.2 Determinant of Profitability

    2.2.1 Capital Structure (Y1)

    Titman and Wessels (1988) argued that the use of debt would increase company profitability. This means that capital structure has a positive effect on profitability. Gill et al. (2011) who researched service and manufacturing companies in America found that capital structure has a positive effect on profitability. These results are in line with research conducted by (Adewale and Ajibola, 2013;Chisti et al., 2013;Goyal, 2013). In contrast, research conducted (Chandra et al., 2019;Dawar, 2014) found a negative effect of capital structure on profitability. This means that increasing the use of debt will reduce profitability. The results of this study are in line with research conducted by (Basit and Hassan, 2017;Işık, 2017;Odusanya et al., 2018;Quang and Xin, 2014). While (Abor, 2005) found a long-term debt negative effect on profitability, while short-term debt has a positive effect on profitability. Long term debt is more expensive than short term debt. So the use of large long term debt will reduce profitability. conversely, the use of short term debt can increase profitability. Adewale and Ajibola, (2013) who examined companies in Egypt also found a positive effect of short-term debt on return on equity. But both short term debt and long term debt have a negative effect on return on assets and gross profit margins.

    In this study, the capital structure indicator uses TD = total debt divided by total assets (Ahmed Sheikh and Wang, 2013;Lazăr, 2016), LTD = long term debt divided by total assets (Ahmed Sheikh and Wang, 2013;Dawar, 2014), and STD = short term debt divided by total assets (Ahmed Sheikh and Wang, 2013;Dawar, 2014). The hypothesis made in this study is:

    • H13: Capital structure has a positive influence on profitability.

    2.2.2 Liquidity (X4)

    Dawar (2014) found that liquidity had a positive effect on profitability. This is due to the increase in liquidity which will reduce interest costs. Similar results were also found by (Işık, 2017). Instead, research conducted by (Vătavu, 2015) found a negative effect of liquidity on profitability. This means that increasing company liquidity will reduce profitability. The hypotheses in this study are:

    • H14: Liquidity has a positive influence on profitability.

    2.2.3 Growth (X5)

    According to Titman and Wessels (1988) growth has a negative influence on long term debt. Companies that are growing will have more choices in investing. As a result, agency costs will increase and ultimately will reduce profitability. Conversely, according to research (Ahmed Sheikh and Wang, 2013) companies in Pakistan tend to use short term debt and under-use long term debt. As a result, agency costs can be reduced and ultimately will increase profitability. In the sense of high company, growth will increase profitability. Besides, companies that have high growth tend to have high profitability as well. The results of research that found a positive effect of growth on profitability are (Ahmed Sheikh and Wang, 2013;Goyal, 2013;Quang and Xin, 2014;Cong and Hoang, 2019). Meanwhile, research done by (Işık, 2017;Odusanya et al., 2018) found no significant effect of growth on profitability. The hypotheses in this study are as follows:

    • H15: Growth has a positive influence on profitability.

    2.2.4 Firm Age (X6)

    Research Dawar (2014) which examines companies in India found that new companies are more able to adapt and make changes compared to old companies in facing product competition in the market; so that the company's profit will be better. This means that there is a negative influence of firm age on profitability. The results of this study are in line with research conducted by (Yazdanfar and Öhman, 2015). In contrast, research conducted by (Chadha and Sharma, 2015a) on companies in India found a positive effect on firm age on profitability. This means that companies that have long tended to have the ability to generate greater profits compared to new companies. These results are in line with the research is (Işık, 2017). While research (Odusanya et al., 2018) found firm age has no significant effect on profitability. The hypothesis used in this study is as follows:

    • H16: Firm age has a positive influence on profitability.

    2.2.5 Uniqueness (X7)

    The more unique a product, the more attractive it will be to consumers to increase the likelihood of its purchase (Cheema and Kaikati, 2010). Consumers with a high need for uniqueness tend to increase purchase intention (Soni and Koshy, 2016). This means that unique products will be able to increase the attention of consumers to buy. If the number of consumer purchases increases, the company’s sales also increase. Increasing company sales will ultimately increase profitability. This means uniqueness has a positive influence on profitability. The hypotheses that can be made in this study are as follows:

    • H17: Uniqueness has a positive value for profitability.

    2.2.6 Firm Size (X9)

    The results of research done by (Ahmed Sheikh and Wang, 2013) found a positive effect on the firm size on profitability. This positive influence is in line with the trade-off theory which suggests that large companies tend to borrow more because of their ability to diversify risk. The maximum use of debt will result in a deductive tax of interest costs, which in turn will result in higher profitability. Research (Dawar, 2014) also found a positive effect on the firm size on profitability. This means that companies in India feel comfortable with economics of scale and can generate higher profits. The results of this study are consistent with the research (Abor, 2005;Adewale and Ajibola, 2013;Işık, 2017;Quang and Xin, 2014;Yazdanfar and Öhman, 2015). Meanwhile, research done by (Lazăr, 2016) found a negative effect on the firm size on profitability. This means that small companies have the ability to generate greater profits. While research (Abor, 2005) found a positive effect on firm size on gross profit, while firm size had a negative effect on return on assets. Research (Gill et al., 2011;Riaz, 2015) found firm size has no significant effect on profitability. The hypothesis in this study can be made as follows:

    • H18: Firm Size has a positive value on profitability.

    2.2.7 Tangibility (X10)

    Dawar (2014) found a positive effect of tangibility on profitability. Dawar suggested that tangibility is more easily monitored and can be a very good guarantee, thereby reducing agency problems between shareholders and debtholders. Instead, the research produced by (Ahmed Sheikh and Wang, 2013) results in a negative effect of tangibility on profitability. The results of this study are in line with research conducted by (Adewale and Ajibola, 2013;Işık, 2017;Lazăr, 2016;Quang and Xin, 2014;Vătavu, 2015). While research conducted by (Chadha and Sharma, 2015a) has a negative tangibility of return on assets and has a positive effect on tangibility on return on equity and Tobinsq. The hypothesis used in this study is:

    • H19: Tangibility has a positive influence on profitability.

    2.2.8 Volatility (X11)

    Vătavu (2015) who examined companies in Romania found a positive effect on volatility on profitability. This means that the higher the risk faced by the company the greater profits the company will obtain. Research conducted (Işık, 2017) found a positive effect of volatility on profitability in a long time company. The results for small companies and new companies obtained a negative effect of volatility on profitability. Meanwhile, volatility for large companies does not have a significant effect on profitability. In this study the following hypotheses were made:

    • H20: Volatility has a positive value on profitability.

    2.2.9 Advertising (X12)

    Dawar (2014) suggested that companies increase advertising costs to increase profits. The results of research conducted found a positive effect of advertising on profitability. These results are also in line with research conducted by (Adewale and Ajibola, 2013). The advertising indicator used in this study is ADV = selling expenses divided by operating expenses (Dawar, 2014). The hypotheses made in this study are:

    • H21: Advertising has a positive influence on profitability.

    2.2.10 Assets Turnover (X13)

    Research conducted by (Chadha and Sharma, 2015a) found a significant positive effect on assets turnover on return on assets. But asset turnover does not have a significant effect on return on equity and Tobin’s Q. The hypothesis used in this study is:

    • H22: Assets turnover has a positive influence on profitability.

    3. THE METHODOLOGY OF THE STUDY

    Based on the hypothesis explanation above, a path diagram can be made as in Figure 1 below.

    Based on the framework that has been stated in the previous section, the structural equation sought and tested for the coefficient is as follows:

    Eq1.gif

    Eq2.gif

    Explanation:

    • γ (Gama) = Coefficient of exogenus variable influence on endogenous variables

    • β (Beta) = Coefficient of endogenous variable influence on endogenous variable

    • ζ (Zeta) = model error

    3.1 Population and Sample

    The population in this study is manufacturing sector companies listed on the Indonesia stock exchange. The period used in this research is 2012-2018. The number registered in the manufacturing sector is 144 companies. The sampling technique in this study used purposive sampling. Where the criteria used are first, the company was registered before 2012. Second, the company was not delisted during the observation period. From the population, 115 companies were fulfilling these requirements; with years of 2012-2018 observation period of 7 years so the unit of analysis of this study was 805.

    The Inferential Statistical Method used in the analysis of this research data is Generalized Structural Component Analysis (GeSCA). The reason for using GeSCA, the consideration that the causal influence formulated in this study uses a model of two-way causality (recurrent) and one-way causality (recursive) and measurement of formative and reflective variables (Aprilia and Ghozali, 2013).

    In the GeSCA analysis measures of fit can be performed on measurement models, structural models and overall models (overall models). Measures of fit in the measurement model aim to check (test) whether the research instrument is valid and reliable. The measures of fit in the structural model aim to find out how much information can be explained by the structural model (influence between latent variables) the results of the GeSCA analysis. While the measures of fit in the overall model (overall model) are a measure of the combined goodness of fit between the measurement model and the structural model, this can be done on the overall model where all variables have reflexive indicators.

    The structural Goodness of Fit Model measured by using FIT, which is equal to the R-square on the regression analysis or total coefficient determination in the path analysis or Q2 in PLS.

    • 1) FIT shows the total variance of all variables that can be explained by the structural model. The FIT value ranges from 0 to 1, the greater this value, the greater the proportion of variable variants that can be explained by the model. If the value of FIT ≥ 0.5 means the model is declared fit and can explain the phenomenon being investigated.

    • 2) AFIT (Adjusted FIT) is similar to R2 adjusted in regression analysis. AFIT can be used for model comparisons, values ≥ 0.5 means the model is declared fit and can explain the phenomenon being investigated.

    • 3) Goodness of Fit Index (GFI) value ≥ 0.90 and SRMR ≤ 0.08 indicate overall model fit.

    4. EMPIRICAL RESULT AND ANALYSIS

    4.1 Goodness of Fit Test

    Before the analysis result using GeSCA is used, the goodness of fit from a model will be used must be tested. That goodness of fit result from this model can be seen on Table 1 below:

    From Table 1 result it can be seen that the whole criteria of FIT, AFIT, GFI, SRMR, shown the fit result. It means that model made was properly able to be used for further analysis.

    4.2 Descriptive Statistics

    Table 2 shows the descriptive statistics in this study. The average of each indicator is illustrated in Table 2. The average total debt for manufacturing companies in Indonesia is 57.09 percent. It means that the proportion of debt is greater than equity. When viewed from the type of debt used by manufacturing companies in Indonesia, it turns out that the proportion of short term debt is more dominant than the long term debt. Short term debt reaches 37.29 percent compared to long term debt which is only 19.82 percent. This causes manufacturing companies in Indonesia to tend to use the short term debt.

    4.3 Empirical Result of Common Factors

    In this structural model, 22 (twenty-two) hypotheses of the relationship between variables are tested. The results of testing the relationship between research variables in full are presented in Table 3.

    After a test done by SEM analysis, the result of the hypothesis is served in Figure 2 below:

    4.4 Capital Structure and Profitability

    Consistent with research from (Adewale and Ajibola, 2013;Gill et al., 2011), capital structure has a positive effect on profitability. This means that an increase in debt will be followed by an increase in profitability. Conversely, profitability also has a positive influence on capital structure. The results of this study are consistent with the trade-off theory, which states that companies that have high profitability tend to multiply using debt. The results of this study confirm the original assumption; there will be a mutual influence of capital structure and profitability.

    From Table 4, it can be seen that by using the reciprocal model (model 1), it can get the results of determination reaching 56.7 percent for capital structure, and 55.1 percent for profitability. Meanwhile, with the same number of constructs, but only connecting the effect of capital structure on profitability, and there is no reverse effect (model 2). It turned out that the result of determination was lower at 33.5 percent for capital structure and 50.8 percent for profitability. Likewise, for Model 3 which only relates profitability to capital structure, it turns out that the magnitude of the coefficient of determination is also smaller than Model 1. These results prove the existence of a very strong reciprocal influence for capital structure and profitability.

    4.5 Non-Debt Tax Shields (NDTS), Effective Tax Rate and Financial Flexibility

    The results of this study found that non-debt tax shields had a significant positive effect on capital structure. This means an increase in NDTS which means an increase in depreciation will be used as collateral for managers to add debt. This additional debt will impact on increasing profitability. These results reinforce the suspicion of the inability of pecking order theory here and are consistent with the research (Chadha and Sharma, 2015b). Meanwhile, the effective tax rate also has a significant positive effect on capital structure. This research is consistent with the research (Alipour et al., 2015) which advises managers to owe because of tax benefits that will ultimately impact on increasing profitability. Construct financial flexibility describes the flexibility of a company in using internal financing. The results of this study found a positive effect of financial flexibility on capital structure. This result is contrary to the pecking order theory. This means that with high financial flexibility, it will encourage companies to increase debt to increase profitability.

    4.6 Liquidity

    According to trade-off theory, companies that have high liquidity tend to use debt as a source of funds. With a lower cost of debt, it is expected to increase profitability. The results of this study are consistent with the trade-off theory, also finding a significant positive effect on liquidity on capital structure. Fluctuations in liquidity owned by manufacturing companies in Indonesia tend to follow fluctuations in the capital structure. Companies that have higher liquidity are more trusted to get loans. With the debt obtained it is expected to get tax deductive from interest expenses so that it can increase profitability.

    In this study, we can also find a significant positive effect of liquidity on profitability. This research is consistent with research conducted by (Dawar, 2014). Increased liquidity will reduce interest costs so that it can increase company profitability. Furthermore, with increasing profitability, it will encourage managers to increase debt.

    Growth has a significant positive effect on capital structure. The results of this study are consistent with research conducted by (Adewale and Ajibola, 2013), which states that companies that have high growth tend to use more debt to avoid information asymmetry. Companies that have high growth tend to use debt funding sources. Debt used is more dominant short term debt. So that it will reduce the occurrence of agency problems which will ultimately reduce agency costs. Reducing agency costs will ultimately increase profitability.

    Related to profitability, this study also found a significant positive effect of growth on profitability. This result is consistent with research from (Ahmed Sheikh and Wang, 2013;Quang and Xin, 2014). Companies that have high growth tend to produce higher profitability. The increase in profitability will also encourage managers to increase the use of debt.

    In this study, firm age does not have a significant effect on capital structure. These results contradict the re-sults of research conducted (Dawar, 2014). In the sense that the company's age is not a consideration of managers in deciding capital structure policies. The credibility of the company in the eyes of creditors does not depend on firm age, but rather on other financial fundamental factors.

    Conversely, a firm age has a significant positive effect on profitability. The results of this study are consistent with the research (Chadha and Sharma, 2015a) in India. The results of this study found companies that have longer lifespan tend to be able to produce higher profitability. This is reasonable, considering that a longestablished company already has a more established network; both, the sales network and supplier network, so that the ability to generate profits becomes more certain and higher. If the profits are more certain and higher, it will encourage managers to add debt; it means that the firm age will not be a consideration for debt holders to provide debt, but if a company that has been long accompanied by the ability to produce high profitability, it will be a debt holder consideration for lending action.

    The results of this study found a positive effect of uniqueness on profitability. The more unique the company's products will be increasingly attractive to consumers so that it will increase sales and ultimately will increase profitability. These results support research (Cheema and Kaikati, 2010;Soni and Koshy, 2016) who find product uniqueness will increase purchase intention.

    Uniqueness has a significant positive effect on capital structure. The results of this study contradict the research conducted (Adewale and Ajibola, 2013). From the results of this study, it can be explained that the more unique a company is, the more attractive it will be and be able to generate sales. Improved sales conditions and increased profitability also encourage companies to take advantage of debt funding. With the increasing use of debt, companies will get tax deductive from interest costs so that they can increase profitability. Assets utilization also has a positive effect on capital structure. These results are consistent with research conducted by (Alipour et al., 2015). The higher the asset utilization of the company means the more efficient the manager is in utilizing his assets. This condition encourages managers to add debt.

    Consistent with the trade-off theory, large companies tend to use larger debt. This study found a significant positive effect on the firm size on capital structure. The results of this study are in line with the research conducted (Chen et al., 2014). Large companies tend to have better credit ratings, making it easier to get debt. This situation is exploited by manufacturing companies in Indonesia, to get bigger debt.

    This study also found a significant positive effect on the firm size on profitability. The results of this study are consistent with research conducted by (Ahmed Sheikh and Wang, 2013;Dawar, 2014). According to the tradeoff theory, large companies can manage debt so that they have a high credit rating. Having a high credit rating will get a lower cost of debt. Besides that, the use of large debt will increase tax deductive from interest costs. So that will ultimately increase profitability.

    This research is consistent with the trade-off theory, which states that companies with high tangibility will require large debts to obtain collateral assets to avoid bankruptcy. The results of this study have a positive effect on tangibility on capital structure. The results of this study are consistent with the research (Chiang et al., 2010;Yang et al., 2010).

    Tangibility also has a positive effect on profitability. This research is consistent with research conducted by (Dawar, 2014) which states that greater tangibility will be easier to monitor and can be used as collateral for debt so that it will reduce agency problems between shareholders and debt holders. Reducing agency problems also means agency costs will be reduced. So that profitability will increase.

    Volatility has a significant positive effect on profitability. These results are consistent with the research (Işık, 2017;Vătavu, 2015). The higher the risk the company encourages managers to achieve higher profitability. Besides, with the company's increasing risk conditions, managers are encouraged to increase their use of debt funds. This is following free cash flow theory, where shareholders will encourage managers to owe so they will be more careful in choosing investments.

    Consistent with research (Dawar, 2014), this study also found a positive effect of advertising on profitability. This means that advertising costs are very effective in increasing sales and ultimately can increase profitability. Turnover assets also have a positive effect on profitability. This study is in line with research conducted (Chadha and Sharma, 2015a). This means that the higher the asset turnover ratio shows the more productive the company is in managing its assets. So that will ultimately increase profitability.

    5. CONCLUSION

    The result of this study found four important things. First, the large companies (firm size) that have high depreciation (NDTS), high effective tax rates, large return earnings (financial flexibility), high liquidity, high growth, have unique products, efficient use of assets (assets utilization), has large fixed assets and high risk, tends to use the source of debt funds, especially short-term debt. The use of debt is expected to increase tax deductive interest costs so that it can ultimately increase profitability.

    Second, large companies that have been operating for a long time (firm age) have great liquidity, good growth, have unique products, have large fixed assets, have high risks, have high asset turnover and dare to pay large advertising costs, then this company will get high profitability. Companies that have high profits will encourage managers to add debt.

    Third, from the results of the analysis, it turns out that capital structure and profitability have a mutually positive effect. It means that capital structure affects profitability on the contrary profitability also affects capital structure. Fourth, the results of the research found that manufacturing companies in Indonesia tend to adopt a trade-off theory, namely using debt as a source of funds. This result is different from the results of a study (Chandra, 2015;Teddy Chandra, 2014) who found companies in Indonesia tended to adhere to pecking order theory. It means that manufacturing companies in Indonesia are more aggressive in using debt to get higher profitability. It's just the proportion of debt which is used the majority of short-term debt. For long-term investment financing, using the short-term debt funding sources will carry a higher risk. It will have implications for the marginal present value of the tax shield to decrease compared to the marginal present value of the cost of financial distress. So that the benefits of adding debt will disappear, it will emerge the negative effect of debt namely the increased risk of financial distress. Indeed, the current increase in debt can still get positive profitability. However, it should be considered that when reaching the optimal capital structure where the marginal present value of the tax shield is the same as the marginal present value of the cost of financial distress, the addition of debt must be stopped (Chen et al., 2014).

    Figure

    IEMS-19-3-561_F1.gif

    Path diagram of structural model.

    IEMS-19-3-561_F2.gif

    Final model.

    Table

    Goodness of fit result

    Descriptive statistics

    The SEM Result structural model

    Model eligibility with R2

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